Woolworths and Wesfarmers - Financial Stability, Profitability, and Efficiency Ratios - Example

Contents Executive Summary 2 Introduction 3 Financial Analysis 3 Financial Stability Ratios 3 Profitability Ratios 8 Efficiency Ratios 12 Conclusion 15 Limitations 16 Recommendations 16 References 17 Executive Summary Woolworth and Wesfarmers are retail players operating in Australia and look to compete against each other by providing similar services and products. Both the giants have looked towards expanding their market by improving their reach and operational efficiency which is witnessed by the growth in sales and coverage thereby ensuring growth for the business. This report presents through the financial analysis different areas one competitor is trying to edge the other. To find the manner in which both the companies are showing growth different ratios pertaining to profitability, efficiency and stability both in the long run and short run have been calculated. This highlights that Woolworth on an overall basis is better placed compared to Wesfarmers as they have a higher return for the shareholder as well as better stability in managing their resources. This highlights that both Wesfarmers and Woolworth has an opportunity where they can bank on in the future and look towards growing their business so that they are able to sustain and develop their market better. Introduction Wesfarmers which is based in Australia provides a range of products for the customer to choose from. The retail player looks to supply insurance products, food products, home improvement products, liquor and similar other products which customers require in their daily lives (Wesfarmers, 2011). The company has persisted with its strategy of offering competitive pricing which has helped them to grow their reach at the same time ensure better market coverage. Woolworth Limited is a competitor for Wesfarmers Limited and looks to deal with the same business model that Wesfarmers follows thereby intensifying competition. The company also provides products which customers require in their daily life and look to regularly update the customer regarding the products and services so that customers can look towards having the knowledge about the product and visit the stores and purchase those (Woolworths, 2011). This report thereby looks into the financial analysis of Woolworth and Wesfarmers by comparing them on various parameters like liquidity, financial stability, profitability, and efficiency so that the financial performance can be compared and the manner the companies have performed can be analyzed. This will thereby help to understand the future opportunity and the manner the organization has performed. Financial Analysis Financial analysis involves analyzing the financial statement so that an understanding regarding the past performance and future policies can be predicted. This helps businesses to ensure that they are able to understand the organization better and based on it look towards investing in the company (Financial Analysis, 2012). Financial Stability Ratio: This ratio helps to understand the stability of the enterprise and comprises of both short term and long term ratios. Short Term Ratios: The short term ratios are as under Current Ratios: This ratio measures the liquidity position and is very vital as it helps to understand whether the investment made by the investor is safe and helps to analyze whether the business will be able to pay back its creditors in a short period of time (Ward, 2012). The ratios are as 2010 2011 Woolworths Ltd 0.73 0.8 Wesfarmerss Ltd 1.23 1.17 Figure 1: Current Ratio The current ratio shows contrasting figures for both Woolwroth and Wesfarmers as the ratio has improved for Woolworth but decreased slightly for Wesfarmers. Despite a decrease in current ratio Wesfarmers the ratio is placed higher compared to Woolworth highlighting better safety of funds for the investors. Despite the changes witnessed in 2011 the ratio for both Woolworth and Wesfarmer is low which might make it difficult for the organization to pay their short term liabilities. This makes it imperative that both the organization looks towards improving it so that they are able to present a better picture for the investors. Quick Ratio: This ratio is similar to current ratio and helps to understand the short term ability of the organization to meet its immediate debt and is calculated after removing inventory as revolving inventory is a time taking process and needs to be looked into before being able to get liquid cash (Ward, 2012). The ratios are as 2010 2011 Woolworths Ltd 0.21 0.32 Wesfarmerss Ltd 0.64 0.59 Figure 2: Quick Ratio This ratio shows a similar trend as shown by the current ratio and highlights that the ratio has improved for Woolworth but declined for Wesfarmers. Despite the fall Wesfarmers has a higher ratio than Woolworth both in 2010 and 2011. The overall picture suggests that the ratio is very low which increases the likelihood of both the company defaulting in paying their immediate debt. This might keep investors away from the company but since retail players have a low ratio the quick ratio is fine for Wesfarmers. Woolworth on the other hand needs towards improving the performance so that they are able to match the competitors and provide the investors safety regarding the investments made by them. Long Term ratio: The long term ratios are as under Debt to Equity Ratio: This ratio has a lot of relevance to investors and loan providers as it helps to understand the debt and equity component of the business. This thereby also makes the organization understand whether looking towards debt or equity financing will be a better option for the organization (Rath, 2012). The ratios are as 2010 2011 Woolworths Ltd 136.48% 168.46% Wesfarmerss Ltd 58.89% 61.14% Figure 3: Debt to Equity Ratio The ratio for the year 2011 highlights increase in the debt component for both Woolworth and Wesfarmers. This brings to the fact that both the organization have looked towards external source of financing. The figures are sound for Wesfarmers but Woolworth has a very high debt competent which will increase the interest burden and create problems to get debt in the future. This makes it important that Woolworth looks towards improving the leverage so that it is able to pose better picture and make the company more lucrative for external sourcing. Debt Asset Ratio (Total Debt): This ratio indicates the debt and asset component and highlights the amount of debt based on asset. Increase in the ratio increases risk as it reduces the chances of the organization to pay its debt by disposing the assets (Rath, 2012). The ratios are as 2010 2011 WESFARMERSS LIMITED 57.71% 62.81% WOOLWORTHS LIMITED 37.06% 37.94% Figure 4: Debt Asset ratio The ratio for 2011 shows increase in the debt component based on assets which increases the risk. The growth for Wesfarmers is very high which multiplies the risk manifolds and requires that the management is able to craft strategies so that the debt is managed more efficiently. The management needs to look towards reducing debt so that the figures look better and makes it possible for the investor towards investing in the company and at the same time also opens the chances of getting loan in the future. Time’s Interest Earned: This ratio helps to understand the interest paying ability on the borrowed funds and also the likelihood of paying the borrowed debt in the future (Rath, 2012). The ratios are as 2010 2011 Woolworths Ltd 12.92 10.92 Wesfarmerss Ltd 4.39 6.14 Figure 5: Time's Interest Earned The ratio shows improvement for Wesfarmers but a decline for Woolworth in 2011. Despite it the figures demonstrates that Woolworth has a higher ratio which shows that the business will be able to pay off its debt and interest on the debt easily. This also puts forward a fact that the management needs to look towards improving the ratios so that the business is able to raise easy finance and at the same time pay it at the correct time. This will help to attract investors and will project a better picture of the organization. Profitability Ratios This ratio has a lot of significance as any one associated with the company looks at the profitability of the company before deciding their future course of action. This ratio helps to understand the manner in which the business is able to conduct their daily operations and comparing it with the competitors help to understand the trends and manner in which the players are able to perform in comparison to the others. The ratios are as Gross Profit Margin: This indicates the profit that the business has been able to earn after charging the direct expenses and is attributable directly to the manufacturing process (Lopes, 2010). The ratios are as   2010 2011 Woolworths Ltd 25.73% 25.78% Wesfarmerss Ltd 30.99% 30.96% Figure 6: Gross Profit Margin The ratio shows consistency for both Wesfarmers and Woolworth thereby highlighting that both the organization has been able to control their expenses which has helped them to control their direct expenses. The difference between both Woolworth and Wesfarmers is also little thereby showing little to choose between the two retail giant. On the overall basis Wesfarmers is slightly better placed highlighting better efficiency and the ability to control direct cost thereby ensuring higher returns for the stakeholders. Net Profit Margin: This ratio helps to understand the bottom line that the business is able to earn from its daily operations and has a lot of relevance in deciding the future planning process of the organization (Lopes, 2010). The ratios are as   2010 2011 Woolworths Ltd 5.96% 6.05% Wesfarmerss Ltd 5.76% 6.11% Figure 7: Net Profit Margin The financial figures highlight little difference between the performance of Woolworth and Wesfarmers in 2011. A close look at the picture suggest that the Wesfarmers has improved its profits drastically as compared to Woolworth but when a comparison is made with the gross profit it shows that increased indirect expenses for Wesfarmers. This shows that Wesfarmers despite having higher gross profit has a higher indirect cost component which has resulted in a huge dip and is an area to watch for. Overall, both the retail giants need to look towards reducing their indirect cost so that they are able to ensure higher earning for the stakeholders. Return on Assets: This ratio helps organization to understand the manner in which the business was able to generate profits by using its assets and helps to understand the manner in which the assets were utilized (Lopes, 2010). The ratios are as   2010 2011 Woolworths Ltd 16.68% 15.54% Wesfarmerss Ltd 7.31% 7.94% Figure 8: Return on Assets The ratio highlights that Woolworth has been able to use its assets better when compared to Wesfarmers despite a dip seen in the ratio for 2011. This shows that Woolworth has ensured efficiency in the use of assets and have ensured better policies so that assets are used to the maximum possible extent thereby ensuring effective utilization of the assets in generating profits. This is an area Wesfarmers needs to work on so that they are able to have assets as per the requirements of the business. Return on Equity: This ratio helps to analyze the earnings that is available to the equity share holders and is based on the final profits. This ratio makes investor look to invest in the company as they are able to understand the appropriate return on their investment (Lopes, 2010). The ratios are as   2010 2011 Woolworths Ltd 26.07% 27.28% Wesfarmerss Ltd 6.34% 7.94% Figure 9: Return on Equity The ratio indicates growth for both Wesfarmers and Woolworth in 2011 but Woolworth has a very high return in comparison to Wesfarmers. This is due to low equity component being held by Woolworth. The high return will make investors look towards investing in the company as the investors are able to get a higher return which will thereby make more investor invest in the shares of the company. Wesfarmers needs to look towards improving it by reducing the equity holding so that investors get a good return on their investments Efficiency Ratios This ratio helps to understand the manner in which the assets were utilized by the organization in generating revenues and shows efficiency of the company. The ratios are as Asset Turnover Ratio: This ratio helps the manner in which the assets were managed in generating revenues and help to find out whether the business was able to hold the correct assets base (Cocheo, 2005). The ratios are as 2010 2011 Woolworths Ltd 2.8 2.57 Wesfarmerss Ltd 1.27 1.3 Figure 10: Asset Turnover Ratio The ratio shows improvement for Wesfarmers in 2011 but a dip for Woolworth. Despite a fall Woolworth is able to use it assets better as they have a higher ratio signifying that the business is able to hold the required assets that will help them to generate the required revenues thereby highlighting efficiency in the use of assets. Debtors Turnover Ratio (Days): This ratio indicates the manner in which the organization is able to collect money from the market and having a sound ratio reduces the chances of bad debts (Cocheo, 2005). The ratios are as 2010 2011 Woolworths Ltd 1.5 2 Wesfarmerss Ltd 10 11 Figure 11: Debtors Turnover Ratio The ratio shows that Woolworth collects its due from the market very quickly which reduces the chances of bad debts in comparison to Wesfarmers which takes slightly longer compared to its competitor. The ratio for Woolworth shows sound policies which will ensure that the business doesn’t loose money through bad debt and will be able to maintain liquidity Creditors Turnover Ratio (days): This ratio signifies the manner in which the organization pays the due in the market and has a role to play in improving the brand image of the company (Cocheo, 2005). The ratios are as 2010 2011 Woolworths Ltd 40 40 Wesfarmerss Ltd 49 50 Figure 12: Creditors Turnover Ratio The ratio shows that both Woolworth and Wesfarmers has been able to pay the money to its creditors after collecting it from the debtors which highlights that the business has been able to mold the resources towards the benefit of the organization. Both the companies have shown consistency and improvement thereby showing improving brand image Inventory Turnover Ratio (Days): This ratio helps to understand the manner in which organization is able to revolve its inventory and being able to manage it efficiently reduces the chances of the inventory becoming obsolete (Cocheo, 2005). The ratios are as 2010 2011 Woolworths Ltd 33 34 Wesfarmerss Ltd 49 50 Figure 13: Inventory Turnover Ratio The ratio shows that Woolworth revolve its inventory better in comparison to Woolworth as Wesfarmers takes around 1.5 months compares to 1 month taken by Woolworth. This also ensures that Woolworth is able to reduce the chances of inventory becoming obsolete and ensures tha the business has inventory as per the requirement of the business so that current asset and liquidity can be maintained. Conclusion Woolworth & Wesfarmers have been able to ensure consistency in performance and the financial analysis of both the retail giants reveals the same. The giants have performed well and have a scope for improvement by being able to manage and utilize the resources efficiently. The analysis presents different strategies being used by each giant and working on a similar business model has also ensured that they target the same base of customer and are able to convert the customers into real ones so that the business is able to grow and pose healthy picture in the future. Limitations The financial analysis is based on historical data thereby it doesn’t consider the inflation level and doesn’t uses the fair value method to calculate the actual scenario The analysis doesn’t look into changing technology, price level, economic condition and other environmental factors which has a relevance on the performance of organization The analysis is limited for two years and analyzing it for a longer period will help to identify important factors which has a relevance on the performance Recommendations The financial analysis for Woolworth and Wesfarmers highlights interesting results as both the players have performed consistently and have been able to grow. The overall performance highlights better performance by Wesfarmers as the company has higher profits and better management of liquidity. This makes it important that investor look towards investing in Wesfarmers as the company has improved and forecast a better future where the returns are bound to go up and will help the investors in generating better opportunity of growth in the future. References Cocheo, S. 2005. The Efficiency Ratio: How good a tool? ABA Banking Journal, 97. on January 4, 2012 from http://www.questia.com/googleScholar.qst?docId=5009692981 Financial Analysis. 2012. Financial Analysis. Microstrategy Inc. Retrieved on January 4, 2012 from http://www.microstrategy.com/financial-analysis/ Lopes, R. 2010. Profitability Ratios. Retrieved on January 4, 2012 from http://cnx.org/content/m15556/latest/ Rath, T. 2012. Debt and Equity Financing: Two Options for Financing Your Small Business. Retrieved on January 4, 2012 from http://sbinformation.about.com/od/creditloans/a/debtequity.htm Wesfarmerss Website. 2012. Retrieved on January 4, 2012 from http://www.Wesfarmerss.com.au/ Woolworths Website. 2012. Retrieved on January 4, 2012 from http://www.woolworths.com.au Ward, S. 2012. Is Your Business Sick? Retrieved on January 4, 2012 from http://sbinfocanada.about.com/od/management/a/3ratios.htm Read More